With retirement on the horizon, you may be tempted to withdraw from your Registered Retirement Savings Plan (RRSP). Perhaps you’re thinking of using some of the money for a purpose beyond retirement, or you’re retiring earlier than you anticipated. But is it time to withdraw yet? It’s important to understand the nuances of early RRSP withdrawals.
What is an RRSP?
A Registered Retirement Savings Plan (RRSP) is the primary savings account that most Canadians use for retirement. RRSPs are registered with the Canadian government, offer tax benefits, and can help you create future income for retirement.
An RRSP offers several tax advantages:
- Tax-free contributing: You can put money in before it’s taxed or receive a tax refund for your contributions.
- Tax-sheltered compounding: Your contributions may grow with interest without being taxed for the investment growth.
- Tax deferring: This allows you to postpone paying taxes until you retire.
What happens to my RRSP when I turn 72?
By the time you’re 72, you’ll be required to convert your RRSP into a Registered Retirement Income Fund (RRIF). This fund pays you an income throughout retirement and is taxed by the Canada Revenue Agency (CRA) as income. Your last day to contribute to your RRSPs is December 31st of the same year that you turn 71. An RRIF is managed by an insurance company, but regulated by the government. It still allows you to earn interest or investment income on your RRIF funds, and you’re not taxed on the interest generated.
Read more about how to financially prepare for your retirement
What happens if I withdraw from my RRSP early?
Early RRSP withdrawals are subject to tax withholding
If you withdraw from your RRSP before it’s rolled into an RRIF, you generally pay a withholding tax on the money you take out. If you wait, you won’t be subject to the same withholding. The way RRSP withdrawals are taxed can cost you if you withdraw large amounts early.
- Withdrawing amounts up to $5,000: 10 per cent withheld (5 per cent in Quebec)
- Withdrawing amounts over $5,000 up to and including $15,000: 20 per cent withheld (10 per cent in Quebec)
- Withdrawing over $15,000: 30 per cent withheld (15 per cent in Quebec)
Early withdrawal could affect your income tax bracket
The amount you withdraw from your RRSP could push your income into a higher tax bracket, since the early transaction will be taxed as income. The withholding percentage that the government takes when you withdraw money early from your RRSPs is not the actual tax amount owed. This percentage is the initial amount withheld until your taxes are filed.
If you’re in a lower income bracket, you may receive some or all of the withheld money back, depending on your income. If you choose to withdraw money early, smaller withdrawals might help you stay within a certain yearly income tax bracket. Be strategic with the amounts you withdraw. Instead of withdrawing $15,000 at once and paying 30 per cent tax, consider withdrawing money in $5000 intervals, so you’re only charged 10 per cent tax on the amounts.
RRSP investments are protected
RRSPs are sheltered from financial hardships like bankruptcy. Investing in the market or in property can be lucrative, especially if you have a financial advisor to help you navigate the waves, but having your funds locked in an RRSP offers security.
You’ll lose the contribution room for your withdrawn amount
Each RRSP has a maximum amount that you can contribute. If you withdraw money from your RRSP early, you also lose the contribution room that money was occupying––even if you pay back the money or want to put it back in later on. With other savings accounts, like a TFSA (Tax-Free Savings Account), you may be able to take money out and put it back in. But once you subtract an amount from an RRSP, that amount is subtracted from your allotted contribution and you can’t get it back.
Residency outside of Canada
If you plan to withdraw funds from your RRSP and plan to live or retire in a country other than Canada, ask your financial advisor about how this may impact your withholding rates or the way your RRSP is taxed. Each country has a different arrangement with Canada.
The kind of plan you have impacts early withdrawal consequences
What kind of RRSP plan do you have? Locked-in RRSPs may not allow you to withdraw funds, but unlocked accounts may allow for withdrawal at any time. Investigate the kind of RRSP your employer offers.
Reasons to withdraw early from your RRSP
In some scenarios, withdrawing money from your RRSP before you have to can be a wise, money-saving decision. You may also be faced with RRSP decisions if you change jobs or start a new business.
Tax-free RRSP withdrawals for education or housing
There are two main ways to withdraw early from your RRSP tax-free. If you don’t pay back either of these withdrawals within the required time frame, the government will consider the money as income and tax you on it:
- The Lifelong Learning Plan (LLP) allows you to withdraw up to $10,000 per year, up to $20,000 towards full-time education or training. This money can go towards you or your partner’s education. After the money is withdrawn, you’ll have 10 years to repay the amount to your RRSP. The LLP can’t be applied to a beneficiary, child, or grandchild––for that you’ll want to look into RESPs.
- The Home Buyers’ Plan (HBP) lets you withdraw money to buy your first home for yourself or a related party with a disability. You can use up to $35,000 of your RRSP to buy a home, and that amount doubles if you’re buying with a spouse. This is also money you’ll have to repay, but you have 15 years to do so.
Convert an RRSP into an RRIF early
Once you reach 55, you can choose to convert to an RRIF. It’s important to remember that if you convert to an RRIF or annuity, you won’t be able to go back or put these funds back into your RRSP. Each RRSP has a minimum amount you’ll need to withdraw in order to set up these regular income payments.
Career investment or maternity leave
If you’re in a life stage where you’re in need of money and your yearly income is low, it could be a good time to withdraw from your RRSP. This is because RRSP withdrawals are taxed as income. So if you withdraw $10,000 and are charged a 20 per cent withholding tax of $2,000, you’ll end up with $8,000. However, if that withdrawn money is all you make in a year (or if you can stay in a low tax bracket after it’s combined with your income), you may get back the withheld $2,000 once you file your taxes. Scenarios like investing in a new business where you’re not pulling a profit yet, or a maternity leave without pay could be times to consider early withdrawal. This can also apply to certain stages of retirement.
Savings options beyond RRSPs
Saving money doesn’t end at retirement, and a mix of savings techniques will give you options at every stage of life. If you’re retiring, you’re likely also thinking about your financial legacy. Whether or not you invest in an RRSP, it’s wise to have a mix of investments and saving strategies before and during retirement. Meet with a financial advisor to build a balanced set of investments, explore trust and estate planning, and consider other strategies like Tax-Free Savings Accounts (TFSAs).
Can I have more than one RRSP account?
Yes, some people have multiple RRSPs. Your employer may have an RRSP where they deposit your automatically-deducted income, and you may also have an RRSP at your bank you contribute to on your own. You can also grow your RRSP while contributing to other savings plans, like a Tax Free Savings Account (TFSA).
What happens to my partner’s RRSP if they pass away?
If a deceased person has a spouse, the two RRSPs may be combined to benefit the living spouse. But without proper planning, your children or grandchildren could be heavily taxed on any remaining money in your RRSP or RRIF left to them. If you plan to leave a financial legacy, make a life estate plan for your RRSP and RRIF so that your loved ones or beneficiaries can keep as much of your money as possible. This is another reason to consider a higher income from your RIFF, with further savings in retirement where your money is put into another savings account. If the money in your RRSP grows bigger, the percentage charged in withholding also grows; so you might actually end up paying high taxes that make it less advantageous to take it out later in life. Ask your financial advisor to explore whether early withdrawals or bigger withdrawals in early retirement might be advantageous for you.
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